Through interviews with prominent PwC tax subject matter professionals, Tax Tracks is an audio podcast series that is designed to bring succinct commentary on tax technical, policy and administrative issues that provides busy tax directors information they require.

Innovation Canada: A Call to Action

You’re listening to another episode of PwC’s Tax Tracks at www.pwc.com/ca/taxtracks. This series looks at the most pressing technical and management issues affecting today’s busiest tax directors.

Gerry Lewandowski: In this podcast, two of our PwC tax partners will discuss the government report "Innovation Canada: A Call to Action" or more commonly referred to as the "Jenkins Report" just released on October 17th.

Vik Sachdev, a partner in our Mississauga office is leader of the PwC Scientific Research and Experimental Development practice (or SR&ED practice) and Tracey Jennings, a partner in our Toronto office, is the leader of our Technology, Information, Communications and Entertainment group.

Welcome to you both.

Tracey & Vik: Thank you Gerry.

Gerry:First some basic background: What's behind the Jenkins Report?

Vik: Well Gerry, in summary, the report calls for a change in the way federal research and development (R&D) support is delivered. Canada relies more heavily on tax incentives, or indirect support, to encourage private sector innovation than most countries. The panel argues that many other countries have achieved more success by promoting innovation relying on a more balanced mix of direct and indirect support. We agree that Canada's broad support, at the expense of support to areas of strategic opportunity, means that Canadian firms in high growth areas have had less support than similiar firms in other countries.

Tracey: That's right, Vik. The Panel was asked to provide recommendations to the government to build on Canada's solid foundation to become a leader in the knowledge economy of tomorrow as well as strategy to harness innovation, key for future growth and competitiveness. The objective is to adopt strategies that address the key challenge that Canada is faced with even though there is significant government spending on R&D, Canada really lags other countries in terms of business innovation. We believe there are other aspects that need to be considered beyond those covered in the report. The challenges for Canada will continue to grow with the shift to the global economy as well and the impacts of the shift to digital.

Gerry:Did the report make any suggestions?

Vik: The report made six broad recommendations.

One is to simplify the SR&ED tax credit and redeploy funds from the credit to direct intiatives that support small and medium-sized enterprises (SMEs). To simplify the SR&ED claim process, the report recommends the credits should be based only on labour-related costs for SMEs. As a result, since the credit would be calculated on a reduced cost base, the report suggests using a higher credit rate to offset the reduction. The report also remarked that eventually, this labour based approach might be extended to larger firms.

I wanted to point out the report assumes a move to a labour-based approach would significantly reduce the compliance and administration costs of the SR&ED program when in fact it's the scientific eligibility of the work in terms of the definition of SR&ED that cause more of the administrative load. There is no doubt that the labour-based approach will assist in reducing some of the compliance; however, there would be more impact if scientific eligibility was addressed.

So, other that a possible future change to a labour based approach, the report did not recommend signficant changes for large companies as we understand the panel found that the tax incentives were working effectively for larger companies.

Gerry:What about non-tax recommendations?

Tracey: Well Gerry, we really welcome the non-tax recommendations.
And they came about because the government asked the panel to consider where gaps existed. In particular, the challenge for high growth innovative companies is to gain adequate access to capital and that was addressed in one of the recommendations. We continue to see a leakage of intellectual capital outside Canada as smaller companies grow and really exit through the sale of their enterprises outside. We fully support the need to provide risk capital as part of a government's strategy to foster innovation. In particular, in the technology and digital media sectors, we know this is one of the biggest challenges and top priorities that we've heard from CEOs.

There are a number of key challenges that the government will face in implementing such programs. PwC's recent research on innovation has found that while there is no one solution, a common characteristic in countries that have been successful in fostering innovation comes from encouraging the creation of new participants through linking of funds to performance.

Gerry:Tracey, did the report exclude any areas that you think could help make Canada more competitive?

Tracey: Yes, there's a key area that has not addressed is the recommendation and that's the existing gap in the overall competitiveness of the Canadian tax system with respect of ownership of intellectual property. This issue is becoming much more prevalent with the growth in the digital economy and ability to locate digital assets anywhere in the world (including in the cloud). Canada has a great base in its foreign affiliate tax regime to build from, and has an opportunity to attract and retain the ownership of intellectual property here by considering how it taxes foreign sourced income earned from the exploitation of intellectual property. We have seen a number of European countries address this issue through the adoption of patent boxes – a type of pull incentive that permits income derived from intellectual property to be taxed at lower rates. Such a mechanism is targeted at the commercialization stage of innovation, where firms only benefit if they generate outputs from their R&D.

Gerry:Now, stepping back from the specific recommendations, how would you characterize the report as a whole - Vik?

Vik: Gerry, we applaud the recommendations around establishing new Canadian infrastructure to support business innovation. We also agree that a good mix of direct and indirect funding will help close Canada's business innovation gap, but we have to make sure we maintain a strong SR&ED program to allow market driven R&D to continue to flourish along side business innovation.

Tracey: The key challenge is really to successfully implement these recommendations. It lies in recognizing the fact that we will need to take risks to really promote innovation. It will require picking areas of strategic opportunities, taking risks and ensuring that the government is also willing to make the appropriate investment. And this is a challenge as it may involve allocation of scarce tax-payer dollars through procurement projects, direct funding to businesses and indirect funding through tax incentives and other programs.

Vik: I agree Tracey. Naturally this means more time is needed for further evaluation including dialogue with industry and working with provincial governments. And as a result, it will be interesting to see what actions the federal government will take from the panel's recommendations.

Gerry: Well, on that note, I'd like to thank Vik Satchdev and Tracey Jennings for joining us today and shedding light on a topic that could be vital to Canada's long-term economic well-being.

For more information on the Jenkins report, PwC has issued two editions of the publication Developments, which are avalable at: www.pwc.com/ca/jenkins-report

The information in this podcast is provided with the understanding that the authors and publishers are not herein engaged in rendering legal, accounting, tax or other professional advice or services. The audience should discuss with professional advisors how the information may apply to their specific situation.

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